Computer software is protected by various areas of intellectual property law, most commonly software patents and copyright law. Under federal copyright law, software is considered to be a “literary work,” just as a book or other print publication. The author of the software has exclusive rights to reproduce, distribute, perform, and display the work to the public.

Unlike many business tools, software is generally not “sold” to a “buyer.” Software is instead generally “licensed” to “users” for a fee. A software license gives the user permission to use the software, subject to the terms and conditions of the license agreement. Absent the user’s assent to the software license agreement, installation and use of the software is otherwise prohibited under federal copyright law.

Off the shelf software

For individuals and small business, most software is purchased at retail in standardized, “off-the-shelf” form. Before home computers and high-speed Internet connections were so common, software licensors ensured consumer consent to their software license agreement by way of a “shrink-wrap” license. The license included a term whereby the user assented to the conditions of the license simply by opening the shrink-wrap packaging for the software. With shrink-wrap licenses, consent occurred without an opportunity to read the terms of the license.

The shrink-wrap license has been replaced by the “click-wrap” license.

Users accept the click-wrap license by clicking or typing “Yes” or “Agree” at the end of the license agreement. The user is forced to read (or at least view) the agreement and agree to the terms. If the user does not agree, the software prevents further use. The click-wrap license addresses the “agree first, read later” criticism that subjected the shrink-wrap license to arguments of unenforceability.

Like many “take it or leave it” consumer contracts, click-wrap software license agreements rarely offer a great deal of rights to the user. For example, the End User License Agreement (EULA) for a popular business productivity suite covers more than five single-spaced pages of text. The EULA grants permission to install and use one copy of the software on just one machine. The license also grants exclusive permission to the “primary user” of the first machine to install and use an additional copy of the software on a second, portable device, such as a laptop.

The implication of these provisions for a small business is that to install and use the software in accordance with the license agreement, it must purchase a license for each user’s computer.

The click-wrap license is laden with restrictions, limitations, and other warnings specifying what the user cannot do with the software.

For example, the EULA grants the user permission to use and modify various artistic features. But by accepting the license agreement, the user has agreed to indemnify the licensor for any losses resulting from that use, or modification of these features. Did you know you may have agreed to pay for the legal defense of a major software corporation against lawsuits by third parties?

Custom software

For larger companies, off-the-shelf software frequently will not satisfy business needs. In response, vendors and consultants offer custom software tailored to specific tasks, industries, and even particular companies.

Among the first steps in creating custom software is defining the business user’s needs, often referred to as the business “requirements” stage of the project. At the requirements stage, both parties must agree upon the features and functionality that the software will have.

It is critical that both parties agree upon the requirements before any development and customization work takes place. For complex software, the business requirements may run hundreds of pages.

Then, over a period of several months or even years, the vendor’s system architects, programmers, and testers work with the business users to create the custom code that makes the software work. As a result, custom software is coupled with multi-year software development, consulting, and/or maintenance agreements, most often billed on a time and materials basis.

Like any “construction” contract, the timing of a software development is a key negotiation point. The agreement should set reasonable, yet clear milestones for deliverables and product testing. The deliverables themselves should be clearly defined and constantly referenced against the business requirements.

Even with a custom product, buyers still generally do not “own” the software. The owner’s rights to use the software again depend upon the terms of the license agreement. As with any software, buyers must purchase individual user licenses. Where custom software offers unique competitive advantages, buyers may insist upon an exclusive license that prevents competitors from later acquiring the software. Because sophisticated buyers often have technology staff capable of further modifying the software, most license agreements also provide such “derivative works” are owned by the vendor, and not the user.

Although no software is free from “bugs,” complete system failures have consequences beyond the software itself. Unhappy customers with unfilled orders may be lost forever. Companies in regulated industries may break the law and be subjected to civil and criminal penalties.

Another key point of negotiation therefore relates to the user’s “acceptance” of the software. Under many license and development agreements, as well as the uniform commercial code, acceptance is a watershed moment. Before acceptance, the user has flexibility in rejecting software that does not work properly or that does not conform to business requirements. After acceptance, non-conforming software instead will be subject to the warranties described in the license.

Thus, users should insist upon significant testing or even “live” use of the software before acceptance occurs. Vendors desire earlier acceptance, such as upon installation for testing purposes or upon delivery of the source code and related documentation.

Warranties

The warranties, liability limitations, and damages and remedy exclusions found in software license and development agreements historically have been extraordinarily favorable to the vendor. Express warranties — statements of fact about the quality and functions of the software — are limited to the promises contained in the license agreement. Implied warranties are disclaimed; remedies beyond repair or replacement of the software are excluded. Consequential damages, such as the harm resulting from unhappy customers or regulatory problems, are non-recoverable.

Courts routinely enforce each and every one of these limiting provisions. Users who have invested in custom software are aghast to learn during litigation that, in practical effect, the vendor made few enforceable promises concerning the future performance of the software.

Remedies are frequently limited to a refund of the money paid for the software license, but not for the years of time and materials incurred during the development process.Even off the shelf software is a significant investment. Care should be taken to understand the ways in which your business is permitted to use its new investment. For more complex systems, the investment should be

protected by thoughtful negotiation before the project starts, not after a dispute has arisen.

Aaron Hartman is an attorney at Fryberger, Buchanan, Smith & Frederick, P.A, practicing in the areas of business litigation and trademark and copyright law. You can reach him in the firm’s Duluth office at 218-722-0861.